April 11 (Bloomberg) -- A plan to give investors the same
level of protection when buying South African investment-grade
corporate debt as they get with junk bonds is dividing the
nation’s money managers.

The proposals being debated include limits on further
borrowing, which will enhance the safety of the debt, said Jason
Lightfoot, a portfolio manager at Futuregrowth Asset Management.
Stricter covenants may reduce the bond market’s attraction as
issuers will have to maintain the debt safeguards on an ongoing
basis, Investec Asset Management’s Simon Howie said.

South African companies last year sold the most bonds on
record, spurred by the lowest interest rates in more than 30
years. Issuance by emerging-market corporates also climbed to
the highest ever, even as concern that Europe’s debt crisis will
spread increased. Defaults by companies worldwide rose to 84
globally from 53 a year earlier, according to Standard & Poor’s.

“The debt-capital market is meant to be a less risky
market, where the bulk of investors are pension or retirement
funds,” Lightfoot, who helps manage the equivalent of $12.6
billion of fixed-income investments at Cape Town-based
Futuregrowth, said a March 6 e-mail. “Why are they not
guaranteed the same protection as banks?”

Bond Sales

The Association for Savings and Investment South Africa,
whose members together manage about 4 trillion rand ($448
billion), is debating standardized debt covenants, the Cape
Town-based body said by e-mail.

Sales of bonds by South African companies rose 36 percent
to $4.5 billion in the first quarter from a year earlier,
according to data compiled by Bloomberg. That compares with a
6.3 percent increase in emerging-market corporate issuance to
$322 billion, the data show.

Prudent underwriting practices have deteriorated with the
inclusion of so-called covenant-light transactions and less-than-satisfactory risk management practices, according to March
22 guidance from the U.S. Federal Reserve, the Federal Deposit
Insurance Corp., and Office of the Comptroller of the Currency.
Covenant-light loans carry fewer safeguards for creditors such
as limits on how much debt a company can add to its balance
sheet.

Risk-Appropriate

Covenants are generally appropriate for the risk and bond
safeguards are different to banks’ conditions “for very good
reasons,” said Cape Town-based Howie, who is head of South
African and frontier credit at Investec, which oversees the
equivalent of $86 billion.

“A bank usually has a wider relationship with the borrower
and is in a better position to negotiate and restructure,” he
said by e-mail. “This is very difficult with a wider group of
institutional investors, which means a breach of a covenant can
lead to liquidation more easily.”

South African companies’ average dollar-bond yields have
declined eight basis points, or 0.08 percentage point, this year
to 4.46 percent yesterday, JPMorgan Chase & Co. indexes show.
That compares with a 13 basis-point increase to 4.85 percent for
average emerging-market company rates.

The rand has depreciated 5 percent against the dollar this
year, making it the worst performer among 25 emerging-market
currencies tracked by Bloomberg after South Korea’s won, which
has slipped 5.7 percent. South Africa’s currency slipped 0.1
percent to 8.9164 per dollar by 2:53 p.m. in Johannesburg.

Monitoring Compliance

Secondary-market trading fragments ownership among a bond’s
initial buyers and limits incentives to monitor the borrower’s
compliance, said Bronwyn Blood, who helps manage the equivalent
of $1.8 billion in bonds at Cadiz Asset Management Ltd.

“For listed public companies in the investment-grade
space, the question is whether covenants are really necessary
and are just adding to the layers of governance required by the
JSE,” which operates the country’s stock and bond exchanges,
Cape Town-based Blood said by e-mail. There’s never been a bond
default in South Africa, she said yesterday.

Asisa has started an “exercise to explore” the
standardization of bond covenants in response to requests from
its members, Adre Smit, a consultant at the organization, said
by e-mail.

The South African bond market is “sound” and higher-risk
investments such as high-yield bonds tend to have more explicit
financial covenants to manage default risk and act as an early-warning mechanism, Jana Kershaw, a credit analyst at FirstRand
Ltd.’s Rand Merchant Bank in Johannesburg, said in an e-mail
yesterday.

Default Swaps

The cost of insuring South African five-year debt rose to
156 basis points from 143 basis points at the beginning of the
year. The spread between the country’s dollar debt due in May
2022 and similarly dated Treasuries has widened 31 basis points
this year to 1.60 percent yesterday.

Having covenants in the high-yield market gives investors
comfort and makes monitoring credit risk an easier task for an
asset that requires “rigorous analysis and in-depth
understanding,” Cadiz’s Blood said.

“Covenants would aid the development of the high-yield
bond space,” she said.